As the country starts to re-open after almost three months of lockdown, the focus for retail landlords and tenants now shifts to the next six to twelve months and beyond. To ease the impact that Covid-19 has had on their businesses, many retail tenants may seek to vary the terms of their existing leases – some may seek to change to a turnover based rent. Turnover based leases became popular after the financial crash in 2008, particularly in shopping centers, and may become more common in the months and years ahead. In times of uncertainty the landlord/tenant dynamic changes to a more risk sharing approach and Turnover Rents embody this.
The “Standard” Lease
A “standard” retail lease usually contains the following structure: -
- 10-year term (on average);
- Agreed level of rent according to open market conditions – the rent is normally set for the first five years of the term; and
- Rent review at the end of the fifth year.
This structure provides certainty for a landlord – rent is guaranteed at an agreed level for a five-year period and is protected against changes in market conditions in the short term.
What is Turnover Rent?
Turnover rent is determined according to the level of turnover generated by a tenant at a retail premises. There are several ways in which it can be structured.examples include: -
- Turnover Only: a rent which is purely based on turnover with no base level of rent; or
- Base Rent supplemented by Turnover Rent: a base rent calculated on a percentage of the open market rent plus a fixed percentage of the tenant’s turnover; or
- Ratcheting: an agreed base rent with annual uplifts or “ratcheting” of the base rent payable. The uplifts will be based on any increase in turnover for the previous financial year.
It is probably most common to see ‘Base Rent’ supplemented by turnover rent and ratcheting. This structure provides some level of certainty for the Landlord (and the Landlord’s funder) as there is a set base rent which is paid regardless of the Tenant’s performance.
The Pros and Cons of Turnover Rent
The advantages of turnover rent include:
- Shared Success: where the Tenant performs well the Landlord also reaps the rewards with an increased level of rent - without having to wait until a rent review.
- Attract new Tenants: Retail tenants who are unsure about entering into a Lease for a new unit may be willing to take a chance if rents are linked to turnover.
- Monitoring: Landlords can monitor tenant performance and plan for the future accordingly.
The disadvantages of Turnover Rent include:
- Landlord’s Perspective: There is a lack of certainty over the level of rent payable – it will depend on footfall and levels of consumer spending which may be difficult to predict in the current climate. The Landlord’s funder may not approve of this uncertain structure.
- Tenant’s Perspective: The Turnover Rent will create more administration for the tenant in terms of documentation to be provided to the Landlord - there will normally be a requirement for regular reporting to the Landlord (providing trading accounts etc.).
Tips for Retail Landlords and Tenants when switching to Turnover Rents
1. Landlords and Tenants need to work together – with a turnover based rent the success of both parties is closely linked.
2. Landlords will want to include a very broad definition of turnover (to include all types of sales from the premises, including online orders/ click & collect and physical sales from the premises). Tenants on the other hand will want a narrow definition of turnover. These elements must be very carefully captured in the Lease to ensure that there is no ambiguity and to avoid disputes.
3. The Tenant will normally be required to furnish regular trading accounts to the Landlord as evidence of turnover. These figures will be scrutinized by the Landlord and it is very important that the Lease contains a mechanism for independent assessment should a dispute arise in relation to the interpretation of the turnover.
4. Technology can assist the parties and ensure delicate information, such as profit margins, are masked when provided to the Landlord.
Given the current uncertainty in the retail industry and the increasing shift by consumers to online sales, turnover rents may be a useful tool for retail landlords and tenants to navigate through the next couple of years and beyond.
Leman Solicitors have extensive experience dealing with landlord and tenant matters. For more contact Karl or any of the team on 01 6393000 or visit www.leman.ie for more information.
Shopping centres could be a battlefield in retail rent row